The DCF, explained

A DCF says something simple: a company is worth the cash it will generate in the future, discounted back to what that cash is worth today. It's the most important valuation method to nail — comps tell you what the market is paying, but the DCF is the only one that values the business on its own fundamentals. It's also where people trip, almost always on sequence, not on math.

Here's the whole pipeline before we break it down:

Step 1 — Project unlevered free cash flow

You forecast the cash the business throws off, typically for 5 years. Use unlevered free cash flow — cash before any debt payments:

$\text{UFCF} = \text{EBIT}\times(1-t) + \text{D\&A} - \Delta\text{NWC} - \text{CapEx}$

Start from EBIT (operating profit, before interest), tax it, add back non-cash D&A, then subtract the real cash drains: investment in working capital and capital expenditures.

Step 2 — Discount at WACC

Future cash is worth less than cash today, so you discount it. The rate is the weighted average cost of capital — the blended return debt and equity holders require:

$\text{WACC} = \frac{E}{V}\,r_e + \frac{D}{V}\,r_d\,(1-t)$

Cost of equity ($r_e$) comes from CAPM (risk-free rate + beta × equity risk premium); the debt term is after-tax because interest is tax-deductible. WACC is the discount rate for unlevered cash flows.

Step 3 — Terminal value

You can't forecast forever, so after the explicit years you capture everything beyond with a terminal value, two ways:

• Gordon growth (perpetuity): $\; TV = \dfrac{FCF_{n}\times(1+g)}{r - g}\;$ — grows the final-year cash flow at a modest perpetual rate $g$ (think long-run GDP, ~2–3%) and capitalizes it.
• Exit multiple: apply a market multiple (e.g. EV/EBITDA) to the final-year metric.

Step 4 — Sum to enterprise value, then bridge to equity

Discount every year's FCF and the terminal value back to today and add them up. That sum is enterprise value — the value of the operating business, independent of how it's financed.

But investors own equity, so you bridge across:

$\text{Equity Value} = \text{Enterprise Value} - \text{Debt} + \text{Cash}$

Divide equity value by diluted shares and you have value per share.

A 30-second version

Say a business throws off $100 of unlevered FCF next year, growing 2% forever, at a 10% WACC. Perpetuity value ≈ $100 \times 1.02 / (0.10 - 0.02) =$ $1,275 of enterprise value. Net debt of $275? Equity value $1,000. Clean round numbers — exactly how you'd do it without a calculator.